How to protect your family business during a divorce

When the business and personal collide it can be ugly — but it doesn’t have to be.

By

DanielThompson

If you own a business, you’re used to tracking various risk variables, such as new competitors, technology changes or supply costs. But have you considered your spouse as a possible downside danger?

Think about it: Divorce is not an unpredictable “black swan” event. Almost half of first marriages end in court; the portion is even higher for second and third marriages.

Couples who own a family business may have gotten together when they were young, and the business probably had little value. As the business grows over the years, it’s not uncommon for a couple to have almost all their net worth tied up in the business. As a result, there usually isn’t enough cash for one spouse to buy out the other.

That can mean the business must be sold or take on a heavy debt load — even if the business was built and managed over the years by only one spouse.

So, protecting your family business from the consequences of divorce is crucial to its survival. And for many couples, the business is the biggest personal asset for each partner.

Here are some mechanisms to use:

A prenup now will save your business later

Of course, if you started the business before your marriage, you can sign a prenuptial agreement that specifies what happens to the company if you get a divorce.

Done properly, prenups can be ironclad, negating even the property-division laws in the nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

The document must be in writing and executed voluntarily before witnesses. It requires full disclosure by both spouses and can’t be “unconscionable.” That means if you’re making millions, you can’t just give your spouse the Keurig and a kiss goodbye.

For people who forgo a prenup, before the wedding is also the best time to set up a buy-sell agreement to protect a family business from disintegrating in a divorce. Also known as a buyout agreement, a buy-sell is a contract between business co-owners that governs the situation if one co-owner dies or is otherwise forced, or chooses, to leave the business.

In a divorce, a good buy-sell agreement would require a former spouse to sell any interest received in a settlement back to the company’s owners at a price set by a specified valuation method.

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Use a trust for generational wealth

A way to protect family business assets in the longer term involves using a trust to shield the next generation in case that generation goes through a divorce.

For example, a father makes a gift to his daughter of $5 million worth of stock in the family business, which is put into a trust that benefits only her. If she marries and later divorces, her spouse can’t touch this money—as long as the gifted stock or stock sale proceeds stays within the trust.

This kind of trust is favored in higher-net-worth situations, but generally, it can’t be used to divorce-proof a business if you and your spouse split up.

Stay together, at least in the business

The best and simplest way, perhaps, to structure a business that can withstand a divorce is for the spouses to continue as co-owners, even as they get a divorce. Unfortunately, this strategy won’t work for many couples, especially those locked in emotional or legal combat..

If you go down this road, though, make sure to have a shareholder agreement drawn up that gives either spouse the right to buy the other out at a mutually agreeable price.

Note that buying out your spouse’s interest in the business requires first evaluating the value of the business, which is not always easy and can in itself be very expensive. Coming up with the money to finance the buyout can also be difficult.

You could use leverage to raise money—that is, add debt to the business to get cash to the spouse who will no longer be involved in the business.

Borrow, buyout, or add a partner

The best route for this is to take out a bank loan; it’s easy and likely will have the lowest cost of capital.

Another option is a property settlement note, which is a long-term loan for a with-interest payout of the amount you owe your ex-spouse for his or her share of the business.

If the business already has significant debt, you could consider adding a partner or going after private equity investment or venture capital. If you choose to add a partner, be sure to include a buy-sell agreement in the deal.

Finally, selling the business and splitting the profits is a straightforward, if not ideal, solution. And if your business is the largest share of your assets, this may be your only choice. One advantage is that if your business sells quickly, you will both soon have money to pursue your own interests. Also, selling the business means you can avoid financial ties to your former spouse. But keep in mind that many companies aren’t easy to sell, so you may be stuck working with your ex for many, many months.

But who knows? You may patch things up and remarry each other. If so, this time, please see above on prenuptial agreements.

Daniel Thompson is a Certified Financial Planner and Regional President for First Western Trust in Denver.

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